Financial Pitfalls To Avoid During Divorce

financial pitfalls

Divorce can be trying enough emotionally, and it is not cost-free – but some costs incurred during divorce can be self-inflicted.

First, every person going through a divorce needs to get real with regards to finances – what can I expect to earn on my own? Will I receive maintenance or child support, and if so, how much? Given that income, what can I reasonably afford? Without a clear financial picture, parties to divorce essentially negotiate in a cloud of speculation, and that typically leads to thinking favoring one’s position, which means an often-mistaken belief in what one can afford. Worse, rather than planning for a realistic outcome, these same parties will plan for a very unrealistic outcome, laying the groundwork for a mountain of debt.

How can this play out in the divorce?

The marital residence is usually the best example. If the parties lived a lifestyle based on the income of one party, and the non-earning spouse wants to keep the marital home, that spouse will have to either negotiate the payment of the house in full (at the expense of other marital assets, often retirement funds) or will assume the ability to pay the mortgage when in fact the non-earning spouse cannot secure refinancing. In the first instance, the non-earning spouse gets an asset that may accrue value at 2-5 percent a year net of maintenance while forfeiting an equal amount of retirement or liquid assets that could earn 10-15 percent a year. In the second instance, the non-earning spouse will have to sell the marital residence and scramble to find a new home, assuming all the costs of the sale.

Sentimentality or lifestyle maintenance can also lead to poor negotiation choices, as one spouse will sacrifice too much to keep property that lacks the same value.

Some spouses will enter a denial phase about returning to the workforce or improving their employment, and they will not cut expenses in the interim, resulting in growing debt shortly after the divorce. An accurate accounting of one’s financial picture at the outset would help avoid such missteps.

Second, never forget to think about taxes and other expenses related to a division of property. If you agree to half of an IRA and roll it over and keep it as retirement, you assume no expense. But if you try and convert the asset to cash or another investment, you could incur penalties, capital gains and income taxes, and other costs that diminish the overall value of the asset. Suddenly, your exchange does not look so equal. Similarly, if you split stocks, and one spouse keeps stocks that have lost money and the other spouse keeps stocks that have made money, even though the value on paper is the same, the tax consequences are totally different – one will result in a tax bill and the other in a tax refund.

Third, if you receive maintenance or child support, you need to consider the fact that the other spouse could die before those sums would be fully paid. The easiest way to cover the shortfall is through an insurance policy that the parties can agree will be paid by the spouse with the obligation. It will be money well spent, as a term life policy for that sum typically runs less than $50 a month, but it could save a family from bankruptcy or worse.

As you can see, thinking about the future and the consequences post-divorce are critical to making informed decisions during the divorce.

If you have questions about financial pitfalls during divorce, contact us – we can help.